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Bertrand Competition in Markets with Network Effects and Switching Costs

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  • Irina Suleymanova
  • Christian Wey

Abstract

We analyze market dynamics under Bertrand duopoly competition in industries with network effects and consumer switching costs. Consumers form installed bases, repeatedly buy the products, and differ with respect to their switching costs. Depending on the ratio of switching costs to network effects, our model generates convergence to monopoly as well as market sharing as equilibrium outcomes. Convergence can be monotone or alternating in both scenarios. A critical mass effect, where consumers are trapped into one technology for sure only occurs for intermediate values of switching costs, whereas for large switching costs market sharing is the unique equilibrium and for small switching costs both monopoly and market sharing equilibria emerge. We also analyze stationary and stable equilibria, where we show that a monopoly outcome is almost inevitable, if switching costs or network effects increase over time. Finally, we examine firms' incentives to make their products compatible and to create additional switching costs.

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File URL: http://www.diw.de/documents/publikationen/73/diw_01.c.84200.de/dp796.pdf
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Bibliographic Info

Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 796.

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Length: 56 p.
Date of creation: 2008
Date of revision:
Handle: RePEc:diw:diwwpp:dp796

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Keywords: Network effects; switching costs; Bertrand competition; market dynamics;

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References

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  1. Farrell, Joseph & Shapiro, Carl, 1988. "Dynamic Competition with Switching Costs," Department of Economics, Working Paper Series qt1h02g9q4, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  2. Farrell, Joseph, 1989. "Converters, Compatibility, and the Control of Interfaces," Department of Economics, Working Paper Series qt8161p50b, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  3. Irina Suleymanova & Christian Wey, 2008. "On the (Mis-) Alignment of Consumer and Social Welfare in Markets with Network Effects," Discussion Papers of DIW Berlin 794, DIW Berlin, German Institute for Economic Research.
  4. Joseph Farrell & Garth Saloner, 1985. "Installed Base and Compatibility With Implications for Product Preannouncements," Working papers 385, Massachusetts Institute of Technology (MIT), Department of Economics.
  5. Caminal, Ramon & Matutes, Carmen, 1990. "Endogenous switching costs in a duopoly model," International Journal of Industrial Organization, Elsevier, vol. 8(3), pages 353-373, September.
  6. Farrell, Joseph & Klemperer, Paul, 2007. "Coordination and Lock-In: Competition with Switching Costs and Network Effects," Handbook of Industrial Organization, Elsevier.
  7. Liebowitz, S J & Margolis, Stephen E, 1990. "The Fable of the Keys," Journal of Law and Economics, University of Chicago Press, vol. 33(1), pages 1-25, April.
  8. Katz, Michael L & Shapiro, Carl, 1986. "Technology Adoption in the Presence of Network Externalities," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 822-41, August.
  9. Beggs, Alan W & Klemperer, Paul, 1992. "Multi-period Competition with Switching Costs," Econometrica, Econometric Society, vol. 60(3), pages 651-66, May.
  10. Rossella Argenziano, 2007. "Differentiated Networks: Equilibrium and Efficiency," Economics Discussion Papers 638, University of Essex, Department of Economics.
  11. Grilo, Isabel & Shy, Oz & Thisse, Jacques-Francois, 2001. "Price competition when consumer behavior is characterized by conformity or vanity," Journal of Public Economics, Elsevier, vol. 80(3), pages 385-408, June.
  12. Neil Gandal, 2002. "Compatibility, Standardization, and Network Effects: Some Policy Implications," Oxford Review of Economic Policy, Oxford University Press, vol. 18(1), pages 80-91, Spring.
  13. A. E. Fernández Jilberto, 1991. "Introduction," International Journal of Political Economy, M.E. Sharpe, Inc., vol. 21(1), pages 3-9, April.
  14. Klemperer, Paul, 1995. "Competition When Consumers Have Switching Costs: An Overview with Applications to Industrial Organization, Macroeconomics, and International Trade," Review of Economic Studies, Wiley Blackwell, vol. 62(4), pages 515-39, October.
  15. David, Paul A, 1985. "Clio and the Economics of QWERTY," American Economic Review, American Economic Association, vol. 75(2), pages 332-37, May.
  16. Angelique Augereau & Shane Greenstein & Marc Rysman, 2006. "Coordination versus differentiation in a standards war: 56K modems," RAND Journal of Economics, RAND Corporation, vol. 37(4), pages 887-909, December.
  17. Matthew Mitchell & Andrzej Skrzypacz, 2006. "Network externalities and long-run market shares," Economic Theory, Springer, vol. 29(3), pages 621-648, November.
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  20. Padilla A. Jorge, 1995. "Revisiting Dynamic Duopoly with Consumer Switching Costs," Journal of Economic Theory, Elsevier, vol. 67(2), pages 520-530, December.
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Citations

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Cited by:
  1. Jiawei Chen, 2009. "Switching Costs and Dynamic Price Competition in Network Industries," Working Papers 09-25, NET Institute, revised Apr 2010.
  2. Christin, Clémence, 2011. "Entry deterrence through cooperative R&D over-investment," DICE Discussion Papers 38, Heinrich‐Heine‐Universität Düsseldorf, Düsseldorf Institute for Competition Economics (DICE).
  3. Keser, Claudia & Suleymanova, Irina & Wey, Christian, 2011. "Technology adoption in markets with network effects: Theory and experimental evidence," DICE Discussion Papers 33, Heinrich‐Heine‐Universität Düsseldorf, Düsseldorf Institute for Competition Economics (DICE).
  4. Gu, Yiquan & Wenzel, Tobias, 2012. "Transparency, entry, and productivity," Economics Letters, Elsevier, vol. 115(1), pages 7-10.
  5. Timothy Keller & David Miller & Xiahua (Anny) Wei, 2010. "A Steady State Approach to a Network Externality Market With Switching Costs," Working Papers 10-19, NET Institute.
  6. Stühmeier, Torben & Wenzel, Tobias, 2012. "Regulating advertising in the presence of public service broadcasting," DICE Discussion Papers 41, Heinrich‐Heine‐Universität Düsseldorf, Düsseldorf Institute for Competition Economics (DICE).
  7. Gu Yiquan & Wenzel Tobias, 2012. "Price-Dependent Demand in Spatial Models," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 12(1), pages 1-26, March.
  8. Haucap, Justus & Herr, Annika & Frank, Björn, 2011. "In vino veritas: Theory and evidence on social drinking," DICE Discussion Papers 37, Heinrich‐Heine‐Universität Düsseldorf, Düsseldorf Institute for Competition Economics (DICE).
  9. Alexei Alexandrov, 2008. "Interconnecting Differentiated Networks," Working Papers 08-07, NET Institute, revised Oct 2008.

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